Rankings and risk-taking in the financial industry

Rankings and risk-taking in the financial industry

20-09-2017 | From the field
Rankings matter. For example, we already know that most money flows towards top-performing funds at a certain point in time. This encourages so called “tournament” behavior among mutual fund managers. At Robeco, we believe that although this pattern is understandable, it may distort asset prices, in particular driving up the prices of risky assets. In this study*, professor Utz Weitzel and his colleagues ran laboratory experiments with more than 1,000 participants, including students and investment professionals.
  • Pim  van Vliet, PhD
    Pim
    van Vliet, PhD
    Managing Director, Head of Conservative Equities - Pim van Vliet

They found that rankings and tournament incentives increase risk-taking among underperforming professionals, but not among students. One reason could be that professionals know that following a low-risk strategy does not increase the likelihood of a fund achieving high rankings, while a high-risk strategy makes more sense under these conditions. This behavior supports the persistence of the low-risk anomaly.

The paper is also of particular interest since most other empirical studies are based on samples of students, who might not be representative for professional investors. Many experiments involving students may underestimate the behavioral impact of incentives.

*‘Rankings and Risk-Taking in the Finance Industry’, Michael Kirchler, Florian Lindner and Utz Weitze, 2017.

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